ADDRESSING CHANGES IN FINANCIAL REPORTING...

B.C. Ziegler and Company | Member of SIPC & FINRA

Alwyn PowellFounder and CSOAV Powell & Associates LLC

Mark RossPartner & Practice LeaderBaker Tilly Virchow Krause, LLC

Tommy BrewerManaging Director Ziegler

PRESENTED BY

October 4, 2017

ADDRESSING CHANGES IN FINANCIAL REPORTING FOR LIFE PLAN COMMUNITIES: ASC 606 REVENUE RECOGNITION

2

OBJECTIVES• Understand the rationale and mechanics of how ASC 606

may affect monthly fee and entrance fee revenue recognition and identify what types of contracts will be affected.

• Discuss actuarial considerations related to the implementation of ASC 606.

• Identify and discuss questions that may be raised by Board members, residents, and other stakeholders on the impacts of ASC 606 on a LPC’s financial status.

3

1 - INTRODUCTION

2 – ASC 606 ACCOUNTING CHANGES

3 – ACTUARIAL CONSIDERATIONS TO IMPLEMENT ASC 606

4 – LIFE AFTER ASC 606

QUESTIONS & ANSWERS

AGENDA

Tommy BrewerManaging DirectorZiegler

1 - INTRODUCTION


2 – ASC 606 ACCOUNTING CHANGES

6

OBJECTIVES OF THE NEW REVENUE STANDARD

*IASB: International Accounting Standards Board/FASB: Financial Accounting Standards Board

FASB/IASB* converged standard

Remove inconsistencies and weaknesses in

existing requirements to improve comparability

Provide more useful information through improved disclosure

requirements

Provide a more robust framework for addressing

revenue issues

Simplify the preparation of financial statements by reducing the number of

requirements by having one revenue framework

7

THE CORE PRINCIPLE AND THE FIVE-STEP MODEL

Coreprinciple

An entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services

Identify the contract(s) with a customer

Identify the performance obligations in the contract

1

2

3 Determine the transaction price

Allocate the transaction price to the performance obligations in the contract4

5 Recognize revenue when (or as) the entity satisfies a performance obligation

8

EFFECTIVE DATE

One year deferral

— ASU 2015-14, Deferral of the Effective Date, defers the original effective date by one year. - Early application would be permitted (but not before original effective

date, i.e., in annual periods beginning after Dec. 15, 2016)

Public business entities and certain not-for-profit entities

— Fiscal years, and interim periods within those years, beginning after Dec. 15, 2017

All other entities

— Fiscal years beginning after Dec. 15, 2018, interim periods in fiscal years beginning after Dec. 15, 2019

9

CCRC SPECIFIC CONSIDERATIONSThe AICPA Healthcare Revenue Recognition Task Force continues to analyze the following primary issues related to CCRCs

• Accounting for monthly / periodic fees and nonrefundable entrance fees under the different contract types (focus has been primarily on Type A Contracts)

• Significant financing component considerations for refundable and nonrefundable entrance fees

• Obligation to provide future services and use of facilities• Contract acquisition costs

10

CCRC CURRENT GUIDANCE - SUPERSEDED

ASC Subtopic 954-605 (revenue recognition) is superseded

ASC Subtopic 954-340-35-1 (costs of acquiring initial continuing-care contracts) is superseded

ASC Subtopic 954-430 (entrance fees) is superseded

ASC Sections 954-440-25, 954-440-35 and 954-440-55(obligation to provide future services and use of facilities) have basically remained intact

11

CONTRACT A resident agreement between the resident and the CCRC would generally meet the criteria in FASB ASC 606-10-25-1 to be considered a contract with a customer to be accounted for under FASB ASC 606.

Because a CCRC resident has the ability to move-out and discontinue paying the monthly fee at any time, the resident agreement for a Type A life care CCRC resident may be viewed as a monthly contract with the option to renew.

CCRCs should consider whether the Type A life care contract contains a lease in the scope of FASB ASC 840 (or FASB ASC 842 after adoption of that Topic).

12

PERFORMANCE OBLIGATION(S)

One view of performance obligations in a resident agreement for a Type A life care resident is that the promised good or service (that is, the performance obligation) is that the resident can live in the CCRC and access the appropriate level of care based on the resident’s needs.

13


Paragraph 42 of FASB ASC 606-10-55 states:

• If, in a contract, an entity grants a customer the option to acquire additional goods or services, that option gives rise to a performance obligation in the contract only if the option provides a material right to the customer that it would not receive without entering into that contract …..If the option provides a material right to the customer, the customer in effect pays the entity in advance for future goods or services, and the entity recognizes revenue when those future goods or services are transferred or when the option expires.

14


One may conclude that the nonrefundable entrance fee paid by a resident under a Type A life care contract contains a material rightbecause, in effect, the resident is paying the CCRC in advance for future goods or services as explained in FASB ASC 606-10-55-42.

15


CCRCs should also evaluate whether the monthly renewal options included in the resident agreement for a Type A life care resident provide a material right to the resident. This evaluation will require judgment and should compare the monthly renewal option with what is offered to other life care residents (that would be considered in the same class of customer), not what is offered to potential residents that would purchase services separately (on a fee-for-service basis). One position a CCRC may take is that the monthly renewal options included in the resident agreement for a Type A life care resident would generally not provide a material right to the resident when comparing renewal options available to other life care residents.

16

REVENUE RECOGNITION;

MONTHLY FEES

As such, a CCRC may take the position that recognizing monthly fees as revenue on a straight-line basis (i.e., when the services for the month billed are performed and the CCRC satisfies the performance obligation) is generally appropriate under ASC 606.

17


ENTRANCE FEES

Judgment is required to determine how to measure when future goods or services are transferred to a CCRC resident.

In measuring progress toward complete satisfaction of a performance obligation, FASB ASC 606-10-25-31 states that “the objective when measuring progress is to depict an entity’s performance in transferring control of goods or services promised to a customer (that is, the satisfaction of an entity’s performance obligation).”

18


ENTRANCE FEES

As required in FASB ASC 606-10-25-32, for each performance obligation, the entity should apply a single method of measuring progress that is consistent with the objective in FASB ASC 606-10-25-31……”

An input measure, such as the cost-to-cost method, may be one method providing a faithful depiction of progress towards complete satisfaction of the future services to be transferred to the residents under Type A life care contracts (i.e., satisfaction of the performance obligations).

19


ENTRANCE FEES

CCRCs may also conclude that it is appropriate to use a time-based measure to allocate the nonrefundable entrance fees to the material renewal rights given the nature of the CCRCs performance is that of having the various services available to residents on a “when-and-if-needed” basis each month.

This would result in a revenue recognition methodology for the nonrefundable entrance fees that is consistent with current authoritative guidance.

20

Illustrations of Potential Entrance Fee Revenue Recognition Model for a Type A CCRC

Note that the illustrations are for discussion purposes only and are not intended to represent authoritative guidance.

21

REVENUE RECOGNITION MODEL FOR A SINGLE RESIDENT –TYPE A OR “LIFE CARE” CONTRACT

Assumptions:

Non-refundable entrance fee 200,000$ Inflation factor 3.00%Expected years in IL 10 Expected years in Assisted Living (AL) 2 Expected years in Skilled Nursing (SN) 2

Estimated annual costs by level of care at contract inception:

IL 20,000$ AL 40,000$ SN 100,000$

22

TYPE A OR “LIFE CARE” CONTRACT PROJECTED COSTS BY LEVEL OF CARE FOR SAMPLE RESIDENT

IL AL SN Total

Year 1 20,000$ -$ -$ 20,000$ Year 2 20,600 - - 20,600 Year 3 21,218 - - 21,218 Year 4 21,855 - - 21,855 Year 5 22,511 - - 22,511 Year 6 23,186 - - 23,186 Year 7 23,882 - - 23,882 Year 8 24,598 - - 24,598 Year 9 25,336 - - 25,336 Year 10 26,096 - - 26,096 Year 11 - 53,757 - 53,757 Year 12 - 55,370 - 55,370 Year 13 - - 142,577 142,577 Year 14 - - 146,854 146,854

Totals 229,282$ 109,127$ 289,431$ 627,840$

Relative values 36.52% 17.38% 46.10% 100.00%

Note: Inflation factor of 3% applied to costs in all levels of care

23

TYPE A OR “LIFE CARE” CONTRACTALLOCATION OF NONREFUNDABLE ENTRANCE FEE TO LEVEL OF CARE

IL AL SN Total

Nonrefundable entrance fee 200,000$ 200,000$ 200,000$ 200,000$

Relative value 36.52% 17.38% 46.10% 100.00%

Allocation 73,040$ 34,760$ 92,200$ 200,000$

24

TYPE A OR “LIFE CARE” CONTRACTREVENUE RECOGNITION OVER PATTERN OF TRANSFER

Revenue ContractRecognized (a) Liability (b)

Inception 200,000$

IL:

Year 1 6,370$ 193,630 Year 2 6,560 187,070 Year 3 6,760 180,310 Year 4 6,960 173,350 Year 5 7,170 166,180 Year 6 7,390 158,790 Year 7 7,610 151,180 Year 8 7,840 143,340 Year 9 8,070 135,270 Year 10 8,310 126,960

73,040

25



AL:

Year 11 17,120 109,840 Year 12 17,640 92,200

34,760

SN:

Year 13 45,420 46,780 Year 14 46,780 -

92,200

Total 200,000$

(a) Nonrefundable entrance fee allocated to deliverables using cost to cost method.

(b) Contract liability is equal to the nonrefundable entrance feeless revenue recognized.

26

Change in Circumstances

Resident is Permanently Transferred to AL at the Beginning of Year 7

Assumes prospective accounting treatment.

27

REVENUE RECOGNITION MODEL FOR A SINGLE RESIDENT –TYPE A OR “LIFE CARE” CONTRACT

Contract liability at end of year 6 158,790$ Inflation factor 3.00%Expected years in Assisted Living (AL) 2 Expected years in Skilled Nursing (SN) 2

Estimated annual costs by level of care at contract inception:

AL 40,000$ SN 100,000$

28

TYPE A OR “LIFE CARE” CONTRACT

Projected Costs by Level of Care for Sample Resident

IL AL SN Total

Year 7 -$ 47,762$ -$ 47,762$ Year 8 - 49,195 - 49,195 Year 9 - - 126,678 126,678 Year 10 - - 130,478 130,478

Totals -$ 96,957$ 257,156$ 354,113$

Relative values 0.00% 27.38% 72.62% 100.00%

Note: Inflation factor of 3% applied to costs in all levels of care

Allocation of Nonrefundable Entrance Fee to Level of Care Based on Cost

IL AL SN Total

Nonrefundable entrance fee 158,790$ 158,790$ 158,790$ 158,790$

Relative value 0.00% 27.38% 72.62% 100.00%

Allocation -$ 43,480$ 115,310$ 158,790$

29



End of Year 6 158,790$

AL:

Year 7 21,420$ 137,370 Year 8 22,060 115,310

43,480

SN:

Year 9 56,800 58,510 Year 10 58,510 -

115,310

Total 158,790$

(a) Contract liability allocated to remaining deliverables using cost to cost method.

(b) Contract liability is equal to beginning contract liabilityless revenue recognized.

30

CCRC Revenue Recognition

What about…..

Couples?

Type B and C Contracts?

CCaH Contracts?

31

Under existing guidance, certain costs of acquiring continuing care contracts when a facility is being initially occupied can be capitalized; subsequent contract acquisition costs are expensed.

In accordance with FASB ASC 340-40-25-1, “an entity shall recognize as an asset the incremental costs of obtaining a contract with a customer if the entity expects to recover those costs.”

Costs of Acquiring

CCRC Contracts

32

FASB ASC 340-40-25-2 indicates that the incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract that the entity would not have incurred had the contract not been obtained.

Costs capitalized are amortized over a period based on the terms of the contract (in a CCRCs case, most likely over the residents life expectancy).

Costs of Acquiring

CCRC Contracts

33

FUTURE SERVICE OBLIGATION

• ASU 2014-09 does not change the guidance related to the calculation of the obligation to provide future services and use of facilities; however, the determination of deferred revenue and deferred marketing costs components of calculation may change

34

REFUNDABLE ENTRANCE FEES

• Refundable entrance fees may no longer be allowed to be amortized into revenue, regardless of contract terms

– 606-10-32-10 - An entity shall recognize a refund liability if the entity receives consideration from a customer and expects to refund some or all of that consideration to the customer……

35

SIGNIFICANT FINANCING COMPONENT

• FASB ASC 606 requires CCRCs to evaluate whether each of their contractual arrangements with residents provide a significant benefit of financing to either party of the contract. The financing component may be explicitly identified in the contract or, may be implied.

• Refundable entrance fees are not part of the “transaction price,” therefore, refundable entrance fees would not be considered in the significant financing component analysis.

36


• BC234 of ASU 2014-09 states “that for many contracts, an entity will not need to adjust the promised amount of customer consideration because the effects of the financing component will not materially change the amount of revenue that should be recognized in relation to a contract with a customer.”

• BC233c states, in part, that “The primary purpose of those payment terms may be to provide the customer with assurance that the entity will complete its obligations satisfactorily under the contract, rather than to provide financing…...”

37


• FASB ASC 606-10-32-17 states that, “Notwithstanding the assessment in paragraph 606-10-32-16, a contract with a customer would not have a significant financing component if the customer paid for the goods or services in advance, and the timing of the transfer of those goods or services is at the discretion of the customer……”

38

DISCLOSURE REQUIREMENTS

Understand nature, amount,

timing, and uncertainty of revenue and cash flows

Disaggregation of revenue

Contract balances

Performance obligations

Significant judgments

Costs to obtain or fulfill a contract

39

DISAGGREGATION OF REVENUE

Example categories

Type of customer (e.g., Medicare,

Medicaid, Private Pay)

Timing of transfer of goods

or services

Type of service (e.g., IL, AL, SN)

Geographicallocation

Type of contract

40

CCRC AUDIT CONSIDERATIONS

What are the terms of the CCRC contract(i.e., what services are included, what are the fees charged for those services, etc.)

What are the processes used by a CCRCto determine the inputs used to establish pattern of revenue recognition at contract inception?• Life expectancies by level of care• Costs by level of care• Inflation factor

Is the CCRC using a specialist to assist with the determination of amounts to be recognized as revenue under the terms of its contracts?

41

CCRC AUDIT CONSIDERATIONS

What are the processes used by a CCRC• to determine whether a significant financing component is present under the terms

of the CCRC contract?• to properly capture the incremental costs incurred related to the acquisition of new

CCRC contracts?

Changes in Controls• Do the controls over CCRC contracts and the accounting for entrance fees and

monthly fees require revision for changes in how information is captured and evaluated?

3 – ACTUARIAL CONSIDERATIONS TO IMPLEMENT ASC 606


43

CONSIDERATION FOR ADOPTING ASC 606

• Option 1—easy to implement since no changes • Option 2—relatively complex to implement• Actuarial and other required assumptions

– Life expectancies– Costs by level of care matching performance obligations– Conventions for resident and contract nuances

• New formula that uses:– Life expectancies by level of care, i.e., performance obligation– <100% of deferred balance used in calculation– Reflects anticipated inflation

44

OBTAINING LIFE EXPECTANCIES BY LEVEL OF CARE (OR PERFORMANCE OBLIGATION)

13.9 14.0

11.1 11.3

8.4 8.8

2.1 1.3

2.1 1.3

2.0 1.2

1.51.7

1.4 1.7

1.4 1.7

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

20.0

CCRC StandardAge-70

CCRC CustomizedAge-70

CCRC StandardAge-75


CCRC StandardAge 80


Female Life Expectancies

ILU ALU/MCARE SNF

45

COST-TO-COST METHODOLOGY REALLOCATES INCOME RECOGNITION

82%

61%

79%

57%

75%

52%

12%

17%

14%

19%

17%

21%

9%22%

10%

24%12%

27%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%


Allocated cost CCRC CustomizedAge-75

Allocated cost CCRC CustomizedAge 80

Allocated cost

Female Residents

ILU ALU/MCARE SNF

46

SIMPLIFIED COMPARISON OF COMPLEX ASC 606 FORMULA WITH LEGACY GAAP FORMULACurrent (legacy) guidance Assumption Result1. Advance fee paid $200,0002. Total life expectancy (11.3 + 1.3 + 1.7) 14.3

3. Income recognized in year 1 (1 ÷ 2) = $13,986Proposed (ASC 606) guidance Assumption Result1. Advance fee paid $200,0002. Percentage of costs in performance level 1 57%3. Portion of advance fee that may be recognized $114,0004. Life expectancy in performance level 1 11.35. Adjustment for revenue inflation of 3% 17.5

6. Income recognized in year 1 (4 ÷ 5) = $6,514

47

STEPS TO COMPLY WITH ONE ASC 606 OPTION• Define historical and future costs by level of care• Generate/obtain life expectancies by level of care• Create new software programs to handle complex formulas• Compare income recognition and deferred balances using

– Current guidance, i.e., legacy method– ASC 606 formula

48

WILL ASC 606 DEFERRED REVENUE BE MATERIALLY LESS THAN CURRENT GUIDANCE?

$0

$10

$20

$30

$40

$50

$60

$70

Milli

ons

Variance < 10%CAVEAT βeta results

Legacy Deferred Revenue ASC 606 Deferred Revenue

49

ASC 606 INCOME RECOGNITION INITIALLY LESS, BUT ULTIMATELY MORE THAN CURRENT GUIDANCE

$0

$1

$2

$3

$4

$5

$6

$7

$8

$9

Milli

ons

Variance= -17% to +10%CAVEAT: βeta results

Legacy Income Recognized ASC 606 Income Recognized

50

CCRC SHOULD EXAMINE WHETHER OR NOT ASC 606 MATERIALLY IMPACTS REVENUE STATEMENT

-20.0%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

Many moving parts in the ASC 606 FormulaCAVEAT: βeta results

% Variance between ASC 606 and Legacy Income Recognized

51

YOUR ASC 606 ASSUMPTIONS MATTER

Cum. Results as of 12.31.16(dollars in thousands)

Deferred Revenue

Percent Variance

Income Recog.

Percent Variance

Legacy (current guidance): $53,950 (6.0%) $91,809 3.9%

Benchmark ASC 606:IL:AL:NC cost ratio 1:1.46:2.50All inflation assumptions match

$57,414 0.0% $88,345 0.0%

Health care inflation: +3% $60,020 4.5% $85,739 (2.9%)

Revenue inflation: -1% $56,700 (1.2%) $89,059 0.8%

Change to AVP legacy standard life expectancies: $57,207 (0.4%) $88,551 0.2%

CAVEAT: βeta results

52

YOUR ASC 606 ASSUMPTIONS MATTER (CONT.)

Cum. Results as of 12.31.16(dollars in thousands)

Deferred Revenue

Percent Variance

Income Recog.

Percent Variance

Legacy (current guidance): $53,950 (6.0%) $91,809 3.9%

Benchmark ASC 606:IL:AL:NC cost ratio 1:1.46:2.50All inflation assumptions match

$57,414 0.0% $88,345 0.0%

IL:AL:NC cost ratio: 1:2:5Based on ASC 606 illus. costs $62,273 8.5% $83,486 (5.5%)

IL:AL:NC cost ratio: 1:1:1Illustrative constant cost $52,885 (7.9%) $92,874 5.1%

IL:AL:NC cost ratio: 1:1.56:2.88Based on client expenses $57,284 (0.2%) $88,474 0.1%

IL:AL:NC cost ratio: 1:2.10:3.58Based on AVP median exps. $60,182 4.8% $85,577 (3.1%)

CAVEAT: βeta results

4 – LIFE AFTER ASC 606



54

CONVERSATION WITH ATTENDEES

• What questions are Boards likely to ask about options?– Are there standard decision criteria to adopt change or not– Is the more conservative option “correct”

• How does ASC 606 affect creditworthiness evaluations?• Do ASC 606 options affect budgeting policies?• Should practices to set fees be changed?• Do ASC 606 financial statements or FSO measure solvency?• Will future GAAP converge to one ASC 606 option?

QUESTIONS & ANSWERS

B.C. Ziegler and Company is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors may be addressed to the National Registry of CPE Sponsors, 150 Fourth Avenue North, Suite 700, Nashville, TN, 37219-2417. Website: www.nasba.org. Attendees are eligible to receive up to 13.5 credits for attendance at the 20th Annual Ziegler Senior Living Finance + Strategy Conference. No prerequisites or advance preparation are required for this group-live educational conference. Program level is basic.

For more information regarding administrative policies such as complaint and refund, please contact our offices at 312-705-7262. No fees are required for senior living providers or capital markets participants (Letter of Credit Banks or Investors). ©2017 B.C. Ziegler and Company | Member SIPC and FINRA

56

• Ziegler is a privately-held investment bank, capital markets, wealth management and proprietary investments firm

• A registered broker dealer with SIPC & FINRA

• Ziegler provides its clients with capital raising, strategic advisory services, equity & fixed-income trading, wealth management and research

• Founded in 1902, Ziegler specializes in the healthcare, senior living, educational and religious sectors as well as general municipal finance

ABOUT ZIEGLER

57

*Investment banking services offered through B.C. Ziegler and Company. FHA mortgage banking services are provided throughZiegler Financing Corporation which is not a registered broker/dealer. Ziegler Financing Corporation and B.C. Ziegler and Companyare affiliated and referral fees may be paid by either entity for services provided.

This presentation was prepared based upon information provided to Ziegler Investment Banking (ZIB) and contains certain financialinformation, including audited and unaudited information, certain statistical information and explanations of such information innarrative form (the “Information”). ZIB believes this information to be correct as of the date or dates contained herein. However, thefinancial affairs change constantly, and such changes may be material. Today’s discussion may contain forward-looking statements,which may or may not come to fruition depending on certain circumstances, including those outside the control of management.Please be advised that ZIB has not undertaken, assumed no duty and are not obligated to update the Information. In addition, pleasebe advised that past financial results do not predict future financial performance. The material in this presentation is designed topresent potential financing structures and options for discussion, however it does not represent a commitment to underwrite bonds,place debt or provide financing and thus should not be relied upon as a promise of financing or underwriting commitment.

DISCLAIMERS

ADDRESSING CHANGES IN FINANCIAL REPORTING...

Documents

Transcript of ADDRESSING CHANGES IN FINANCIAL REPORTING...